Executive Summary

As the financial planning profession matures, there is a growing interest in the opportunities to buy and sell financial planning practices, both for investors, for existing firms looking to grow, and for new planners looking to enter the business. However, industry statistics suggest that relatively few deals are happening (and are generally only for larger firms), although it’s not clear whether the lack of small firm activity is because the transactions are simply underreported, because financial planning firm owners aren’t actually exiting as quickly as the demographics would suggest, or perhaps because most firms just really aren’t valuable enough to sell in the first place.

Nonetheless, for many newer financial planners, who may find the thought of building a client base to be daunting, there is growing interest in acquiring an entry path to a financial planning firm, rather than building one from scratch. Unfortunately, though, the reality is that the opportunity may not quite be all it appears, given the poor economics for many financial planning firms means the new planner is likely buying a job but not a business, the limited capital that many new planners have to acquire a firm, and the outright challenges of diving full steam into both the management of a financial planning business and clients with little experience. While this may not entirely dissuade prospective new planners from buying their way into a firm, the fact remains that the approach merits a great deal of caution as well.

The second scenario is where a new planner wants to buy a practice as a way to jumpstart his/her own firm; sometimes it is envisioned specifically as a desire to be the succession plan for an existing advisory firm, and in others it’s simply intended as a faster way to get clients and get a practice up to speed than doing it organically, one new client at a time. Given how slow it can be to ramp up a financial planning firm from scratch, and the income gap that occurs, the thought of buying a revenue stream is often far more appealing than the slow build, especially for those who are career changers that have family and other obligations and therefore have a stronger need to get revenue going quickly.

The important caveat, though, is that these different approaches affect the mentality of the buyer. While the first group is often trying to buy revenue (to gain business scalability) or outright purchase a profitable business, the second group, comprised of new planners, are often trying to just buy a job (with the hopes of earning a paycheck). As a result, the latter often make a poor or hasty decision to enter a practice, without enough due diligence to focus on the underlying business fundamentals and a true measure of value.

Valuing A Financial Advisory Practice For Purchase

In theory, the purchase price of a firm should be dictated by the potential net profits that can be derived from the practice over time – or more accurately, the discounted present value of its future net cash flows. Accordingly, the price would settle at a level that allows the buyer/investor to generate a reasonable net return on investment, including an appropriate risk premium to the expected return for the risk of buying a small company. In practice, this might equate to an expected return as high as 15% to 25%, as a reasonable risk-adjusted return for what amounts to a micro-micro-cap stock. This expected return corresponds to a valuation (or P/E ratio) of about 4 to 7 times profits. The more stable the company, the lower its risk premium, and the higher its multiple of profits. Notably, at a high end of almost 7 times earnings and a firm that generates a 30% profit margin, this amounts to a purchase price just over 2x revenue, the commonly cited “going rate” for a highly profitable and stable financial advisory firm.

Of course, a third-party investor doesn’t typically intend to work in the practice; as a result, it’s important to note that the valuation of the practice as a multiple of profit should be calculated after including the cost necessary to pay an experienced and skilled financial planner to deliver services to clients (in addition to any other supporting staff functions). Solo practitioner financial planning firms often fail to make this distinction, not realizing that a business income of $200,000/year might simply be a fair market value for the services rendered in the business, which actually means the net profit after replacing the owner could be $0! Unfortunately, though, the reality is that if there wouldn’t be any profit left after a qualified financial planner is hired and paid a fair market wage to render services to clients, the firm may actually have no real economic value! Thus, as Mark Hurley of Fiduciary Network has stated, as many of 98% firms “currently have no enterprise value and are very unlikely to build any in the future as a standalone business.”

However, as noted earlier, most of those looking to buy financial planning practices are not in the position of third-party investors; the goal is not to generate a return on investment, per se, but to “buy” that $200,000/year job. In turn, this means that many financial planning practices actually can sell for more than the “$0 enterprise value” implied by Hurley and a traditional valuation mechanism, but will still generate far less than the commonly cited 2x revenue estimate that would apply if the practice legitimately generated a healthy profit margin after covering the cost to replace the original firm-owner-as-financial-planner.

Risks And Challenges Of Buying An Advisory Firm

So what are the risks and challenges involved for a new planner buying a financial advisory practice?

The first is simply that the clients do not transition successfully from the prior firm/planner to the new owner/planner – meaning either the clients are not willing to sign paperwork to engage the new planner (e.g., refuse to sign over discretionary investment authority or a new financial planning agreement), or the clients decide to seek out a new planner and don’t retain/renew after the first year or two. The way this risk is at least partially mitigated is by structuring a purchase with an earn-out provision that adjusts the payment obligation based on the number of clients that are actually retained and transition successfully. In addition, most deals are structured with only a limited payment up-front (e.g., 20%), and the remainder paid out over a span of 5-7 years; the amortization of a purchase over that time period allows the deal to be financed primarily from the income derived from the practice itself, at least if the business is reasonably profitable, although clearly cash flow problems can still occur if the business is not profitable or not run well… especially in situations where the business itself is not actually profitable outside the income taken by the owner for services rendered in the business. In turn, this means the new owner may earn little for the first several years while servicing the purchase payments for the practice, especially if there were no substantive profits in the first place and the payments would have to come directly from the new owner’s compensation! (If that’s concerning, then perhaps it’s time to reconsider if ownership/partnership is the right path in the first place!)

Of course, the real goal of the purchase is not just to be protected from the clients failing to transition in a manner that’s cushioned by an earn-out; it’s to ensure their smooth transition, to allow for subsequent growth and increased revenue and profits! Although best practices are still emerging about how best to execute a transition of clients, it appears that having a formal plan that eases clients through over the span of a year or so is best. First the new planner is introduced in person by the prior planner. Then a subsequent review meeting occurs with both planners present but the new one driving the meeting. And by a third meeting a year later, the new planner flies solo. Clients that are transitioned too quickly are less likely to retain. (In longer succession planning scenarios, the transition may be spread out over an even longer period of time.)

In addition, it’s important that there be some continuity in the nature of services provided to clients. In point of fact, the most common reasons I hear of financial planning business transitions that fail all have to do with differences in the philosophy of how the new buyer approaches client issues compared to the prior owner. For instance, if the prior owner was focused on using passive indexing and the new planner prefers using actively managed strategies, clients may reject what they perceive to be a new and different investment philosophy (or vice versa going from active to passive). Similarly, if the prior planner tended to craft complex and thorough financial plans and the new owner prefers to deliver recommendations with a client conversation and illustrations on a yellow pad, clients may reject the shift in financial planning philosophy. So if you’re considering the purchase of a planning practice, make sure the investment and planning philosophies of the buyer and seller are at least reasonably in-line with each other in the first place! Notably, this is also a reason why a transition that is “too slow” can actually be problematic; transitioning clients smoothly is one thing, but an overlap that lasts too long can highlight or exacerbate conflicts regarding business management decisions between the prior and new owners.

Where Do You Find Firms To Buy? FP Transitions, RIA Match, & More…

Unfortunately, the marketplace for actually matching prospective buyers and sellers of financial advisory firms is still rather inefficient. In part, this is due to the reality that a lot of financial planning firm owners don’t necessarily want to publicly announce that they plan to exit the business by listing it for sale, for fear of how clients and/or staff may respond. In other cases, it’s simply because there aren’t a lot of options about where to “list” a practice for sale even for someone who wishes to sell.

However, options are emerging. One of the longer standing firms that provides services to buyers and sellers of financial planning firms – including lists, as well as valuations and consulting – is FP Transitions. More recent options include services like RIA Match, and “matchmaker” platforms that have emerged from many of the most popular RIA custodians (e.g., Schwab, TD Ameritrade). An increasing number of broker-dealers also offer internal services to help registered representatives sell their practice to another advisor within the broker-dealer platform (although clients can be transferred externally in many cases, an internal transition is often still easier). (Note: If you have additional resources to suggest on where to find a financial advisory practice to buy, please share in the comments!)

In addition, many deals for firms still occur through good old-fashioned networking, either through custodian or broker-dealer regional or national meetings, or via the major membership associations like the FPA, NAPFA, or IMCA. Networking through local association chapter meetings can be particularly effective, as it ensures that the buyer and seller are in reasonable proximity to one another (as opposed to meeting at national conferences where the buyer and seller may be on opposite sides of the country!).

Certainly, in a world with tens of thousands of small financial advisory practices, the matchmaking process isn’t easy, and industry estimates suggest that not a lot of Merger & Acquisition activity is really happening (although it’s likely that many “small firm” transactions are simply not reported in the wider industry press that can be tracked). Or perhaps the reality is that very few deals really are happening, either because financial planning firm owners don’t actually want to exit after all, or for the simple reason that most firms really may not have a lot of enterprise value. While there arguably is some value to “buying a job” the reality is that the price of such a business may be far less than the seller had anticipated… which means, in reality the greatest challenge to buying your way into a firm may simply be finding a price that both the buyer and seller can live with in the first place.

Related

Good insights. It’s good that you have made the distinction between enterprise value for a 3rd party investor (or more specifically, the owner of an RIA firm buying a practice that he would need to pay someone to service), and a solo practitioner that is essentially “buying a job”.

I am in a small market, and what I tend to see is a lot of small firms hiring someone and doing an internal succession plan, where the “transaction” would not be reported per se.

I am also starting to see more large indy broker firms and RIA’s bringing on wirehouse advisors and essentially “buying” their practice by bringing them on. These also don’t really get reported as traditional “purchases”, but it is certainly a method by which firms are growing.

Ron Sydney

Mike,

Thanks for the detailed info.

I’ll admit- this isn’t a business type I’ve ever considered acquiring, because of some of the challenges you named. But this sort of opened up my eyes that this is a viable option, and could be an even better option in the future.

Loss of clients sounds like one of the biggest challenges in an acquisition. Most other types of business that are sold usually retain most of their clients which is appealing to the new owner.

If current owners are eager to sell, perhaps they could take steps toward ensuring that current clients DO stay with the firm despite the change in ownership? Talking to clients beforehand could solve this. I’m just thinking out loud hear. Who knows if this is doable or not.

Michael Kitces

Ron,
There are plenty of best practices out there to facilitate 6-18 month transitions focused on efficiently transferring clients. A *minimum* is several meetings with clients to announce the change, introduce the new planner, do the handoff, etc. Unless the prior owner unexpectedly died, no one just walks in as the new planner and starts seeing clients cold.

Mike-
How do you arrive at your example of a planner earning $200,000 per year? Is this derived from industry surveys or what?

VG

You don’t earn $200K???? What’s your problem???

Shaun Carney

Mike,
Is one option for finding potential buyers/sellers by posting comments to your blog? If so, I am interested in discussing purchase options with prospective sellers. We could structure a deal to let the current owner transition on his/her own timetable. I am currently looking for owners looking to transition in the next 2-7 years. If interested in working with a highly self-motivated, disciplined, competitive, passionate buyer, then please e-mail me at shaun.carney@hotmail.com or find me on linkedin. Mike, thanks for sharing all of your ideas.
-Shaun Carney

KD

In response to “Note: If you have additional resources to suggest on where to find a financial advisory practice to buy, please share in the comments!”

Succession Link is similar to FP Transitions in that they have listings and provide valuations. Additionally, there aren’t any listing or transaction fees either. Right now they’ve got over 40 listings. They charge buyers subscriptions to look at listings though, but its a pretty novel idea given that more advisors seem like buyers than sellers.

Sean

There is a new company that does these evaluations called 3xequity. Has anyone checked them out?

Ted

Actually, I think one of the primary reasons practitioners use this method is the lack of will or skill around organic marketing. I have never bought a practice to grow our asset base. I’d rather create my own problems.

VG

Mikey, my boy, you’ve hit the head on the nail!!! You’ve managed to hit everything (!) I’ve thought as I’ve looked at other practices to assume (consume); and you’ve also covered BOTH the seller’s and the buyer’s REAL evaluation points.

As a buyer, I’m not looking to pay a premium for non-repeating revenue. But, as a seller who looked to dump a line of business years ago, I wasn’t trying to give my revenue away either. In fact, I determined that “driving the bus off the cliff” would be far more profitable than selling for (in this case) 50% down, plus an earnout. Instead of 1.5-2.5x, I ultimately earned 8-10x on that block of business over a moderately longer time frame.

I guess, in the end, Match(anRIA).com may be a good solution in some cases, but sitting at the bar to find a soul-mate (instead of a f-buddy) is probably problematic in many cases; we’re in a highly personal business.

Just food for thought. And, thanks for your thoughtful insights.

Drew Miler

This is an excellent article covering a lot of the key issues on buying a practice.

I write about financial planning strategies and practice management ideas, and have created several businesses to help people implement them.